Cutting Oil and Gas Tax Subsidies a Small but Responsible Step
There are few subsidies more polarizing than those for oil and gas drilling. Increasingly, however, the public tide seems to be turning against the subsidies. The president has been targeting them for repeal, and last week, the Senate came just a few votes shy of ending a slew of tax subsidies for oil and gas companies. While the subsidies are small compared to the forecasted $10.7 trillion 10-year deficit, ending the give-away to oil and gas companies that currently enjoy record-setting profits is a popular and fiscally responsible choice.
Oil and gas subsidies have played an important role in American politics for more than a century. As the nation rapidly expanded at the end of the 19th century, explorers began finding large oil fields throughout the United States. American oil producers became wealthier, and their political power grew with their wealth. In the early 1900s, they began to exercise this power in the political sphere, winning many concessions and favorable tax treatment. One of the most important was the oil depletion allowance, passed in 1913, which allowed oil companies to shield up to 27.5 percent of their profits from taxation.
Today, there are a wide range of oil and gas subsidies. The three largest subsidies cost the federal government more than $40 billion over ten years. All three of them essentially allow oil and gas companies to deduct normal business expenses, allowing them to reduce the taxes they pay.
The first subsidy benefits many American businesses and is not specific to oil and gas companies. The domestic manufacturing deduction allows companies to deduct a certain amount of their income simply for manufacturing goods in the United States. Beginning in 2004, Congress changed the tax code so that oil production could be considered a manufacturing activity. This allows oil companies to use the deduction to shield up to six percent of their net income from taxation. The addition of this loophole costs the government $18 billion over ten years.
The second major fossil fuel subsidy allows oil and gas companies to expense “intangible” drilling costs. This deduction, which has been in the tax code since 1913, allows oil companies to deduct a range of non-drilling costs, such as surveying, well development preparation, and wages leading up to drilling. Since 1986, this deduction has allowed major oil companies to deduct 70 percent of these basic expenses of doing business. The Congressional Research Service, Congress’ nonpartisan research arm, notes that this expensing “allows for a quicker return of invested funds through reduced tax payments,” thus making drilling itself a less risky investment. Expensing intangible drilling costs the U.S. more than $12 billion in revenue over ten years.
The third subsidy is the percentage depletion allowance. Similar to the intangible drilling expensing, percentage depletion allows companies to recover the cost of their capital investments by deducting 15 percent of the revenue from the sale of oil and gas from their gross income (essentially depreciating oil fields similar to depreciating a piece of capital equipment). Percentage depletion used to allow up to a 27.5 percent deduction, but in 1975, Congress eliminated the deduction for major oil companies and reduced it for the rest. However, it still affects a number of wells owned by large companies, and eliminating the deduction would give the government another $11 billion over ten years.
With oil and gas companies reaping record profits, it is becoming hard to justify the continuation of the subsidies. As the Obama administration has pointed out, “In 2011 alone, the three largest American oil companies made a combined profit of more than $80 billion, or more than $200 million per day.” The five biggest oil companies earned $137 billion in profit in 2011. And despite these record profits, the oil and gas industry laid off more than 11,000 workers between 2005 and 2010. Meanwhile, environmental disasters, such as the 2010 BP/Deepwater Horizon oil spill in the Gulf of Mexico, are bringing the government’s relationship with oil and gas companies under greater scrutiny. As a result of the recent negative publicity, a recent poll showed that 73 percent of Americans would approve of ending federal subsidies for oil and gas companies, making it one of the most popular budget and revenue options polled.
While the industry’s subsidies were generally protected under the previous administration, the Obama administration has repeatedly called for eliminating many fossil fuel subsidies, including the three listed above. All told, the president has called for removing some $30 billion in preferential treatment for fossil fuel companies. Last week, the Senate voted on a bill by Sen. Robert Menendez (D-NJ), which would have repealed six subsidies for the five largest oil and gas companies, saving $24 billion over ten years. While the bill failed to pass, it only fell a few votes short, and the fact that the bill even came up for a vote at all is a sign that oil and gas subsidies are coming under increasing fire.